Climate insurance

Written on the 16 October 2009

SCEPTICS abound when it comes to climate change debate, but in the view of University of Queensland School of Economics head Flavio Menezes, uncertainty is no excuse for inaction. With the Emissions Trading Scheme (ETS) set to cost between 1 to 3 per cent of GDP, Menezes puts these costs into perspective as an ‘insurance’ against catastrophe, whether it happens or not.

When we drive to work in the morning we are always faced with the uncertainty of whether we will have a car accident. In fact, many of us feel it is probably unlikely we will be involved in a car crash tomorrow, yet society still finds a portion of salaries to pay for insurance just in case.

This human tendency to insure against possible misfortune is very important in the debate of uncertainty between climate change and human activity. While the best science shows significant losses are highly likely unless we take action, there are still those who argue against policies to tackle carbon emissions. But consider that in our daily lives we face small probabilities of life-threatening serious events and most of us respond to these by buying life, health, car and home insurance – all going to show that uncertainty is no excuse for inaction.

Climate change mitigation is like car insurance for the climate.

The decision of how to deal with climate change will be one of the most significant our society has to make. Taking as a given the scientific evidence that climate change is caused by human activity through the emission of carbon dioxide (CO2), the failure to comprehensively address climate change could have devastating consequences, such as higher temperatures, more severe droughts and storms, and the extinction of species. The economic impact of global warming on agriculture, health, and population displacement represents a shock to the world economy of a magnitude several times larger than that of the recent global financial crisis.

The hindrance here is that some people see climate change mitigation as a lost cause, but this is not the case. With the help of economists, the developed world has already overcome seemingly intractable problems like urban smog from sulphur dioxide (SO2) emissions, as well as the holes in the ozone layer caused by chlorofluorocarbon (CFC) gases. The elimination of CFCs was achieved through a ban and the reduction of SO2 emissions was achieved through a cap and trade system, as it wasn’t practical to ban the latter – a by-product of many industrial activities. The goal then was to achieve a reduction in SO2 emissions at the least cost possible, in the form of either a tax or a cap and trade regime.

A tax on pollution ensures that only pollution reduction efforts that cost less than the tax are undertaken. But under a tax there is uncertainty about the size of the pollution reduction. In contrast, by capping total emissions and requiring polluters to buy permits, the market discovers the least-cost way of reducing pollution and an exact level of pollution is guaranteed — efficient producers benefit as they have to buy fewer permits than less-efficient producers.

Scientific evidence points to a need to substantially reduce net CO2 emissions relative to business as usual scenarios, whereby a cap and trade system might be the best to create incentives to reduce, absorb and offset emissions. Indeed, this has been the reasoning behind the government’s decision to introduce the ETS. How much will it cost? Estimates suggest a cost of 1 to 3 per cent of income, or $10 billion to $30 billion a year. Queenslanders will pay a large proportion of these costs, given our emissions and industry profile.

So is $10 billion to $30 billion a lot or a little in terms of Australia’s spending? This should be put into perspective — Australians spent more than $1 billion going to the movies in 2008 and the total sales of video games amounted to around

$2 billion – all discretionary spending items. The total revenue from the hospitality industry was about $51 billion, the revenue from gambling totaled more than $15 billion, petrol retailing revenue was $32 billion, while car retail sales amounted to $58 billion.

To be clear, I am not passing any judgment on these expenditures but am merely pointing out some of the trade-offs that we face, if we want to reduce and reverse our impact on climate change. So no matter what uncertainty we are faced with, the costs of taking action may not be as significant as some analysts suggest.

But the costs of doing nothing on the other hand? Perhaps advocates of inaction should start saving now and buy property in the hills, if they haven’t done so already.